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More On Legal & Compliance

from The Advisor's Professional Library

The Few and the Proud: Chief Compliance Officers
CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.

Disaster Recovery Plans and Succession Planning
RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.

Among recent enforcement actions by the SEC were charges against formerly unknown inside traders in the Heinz case. Meanwhile, FINRA actions included the expulsion of a California firm from membership and the barring of its owner, and sanctions and fines against private placement sales, supervisory failures, and execution failures.

Thornes & Associates Investment Securities, a California firm, was expelled from FINRA while its owner and principal, John Thomas Thornes, was barred from associating with FINRA members after findings that Thornes, both directly and through his firm, used the proceeds from two trust funds in his care for his own purposes.

FINRA found that the firm, with Thornes as president, and Thornes himself and as broker of record, converted and improperly used a total of nearly $4.2 million that belonged to two trust accounts — one benefiting an elderly widow and one set up for the awarding of educational scholarships.

Thornes identified the transfers as loans to friends, but they have never been repaid and Thornes never had any reasonable expectation that they would be. He also used high margin in the trust accounts and caused them to liquidate conservative investments in making the loans. As a result, both trusts were mostly depleted of assets.

In addition, Thornes, in his capacity as anti-moneylaundering compliance officer, failed to monitor or investigate multiple red flags and third-party wire transfers in accounts for which he was the broker of record. The firm also failed to take action on these issues, and also, together with Thornes, failed to implement policies and procedures that would have monitored and investigated such instances.

FINRA also found that Thornes acted as the trustee for the widow’s trust and received compensation at the same time he was serving as the registered representative of the trust. He also deliberately did not amend his U4 to reflect that he engaged in other business activity as a trustee of the widow’s trust.

While neither admitting nor denying FINRA’s findings, both he and the firm consented to their entry and to the expulsion and bar.

SEC Charges More Traders in Heinz Acquisition Case

Two brothers in Brazil have agreed to pay $5 million to settle SEC charges that they were behind suspicious trading in call options for H.J. Heinz Co. the day before the company publicly announced its acquisition.

Earlier in the year, the SEC filed for an emergency freeze action against a Swiss-based trading account that was used to bring in more than $1.8 million in advance of an announcement by the H.J. Heinz Co. that it was being acquired by Berkshire Hathaway and 3G Capital in a $28 billion deal.

According to the agency, Rodrigo Terpins acted on nonpublic material information he got from his brother, Michel Terpins, to purchase the Heinz options while he was on vacation at Disney World in Florida. The latter Terpins found out about the planned acquisition by an investment consortium that included 3G Capital, and told Rodrigo, who bought nearly $90,000 in options through Alpine Swift, a Cayman Islands-based entity that holds assets for one of their family members. He did so even after a broker at Alpine Swift told him that the company was rated “sell.”

The Alpine Swift brokerage account was used to buy 2,533 out-of-the-money June $65 calls, which amounted to a bet that Heinz would rise by about $5 per share. The trade was then executed through an omnibus account at Goldman Sachs’ Zurich office, thus avoiding disclosure of the beneficial owner.

The Terpins brothers and Alpine Swift, which has been named as a relief defendant for the purposes of recovering ill-gotten gains, have agreed to disgorge the entire $1,809,857 in illegal profits, and the Terpins brothers have further agreed to pay $3 million in penalties. The settlement is subject to court approval.

FINRA Says Firm Sold Private Placements, Failed on ETFs

Kansas City, Missouri-based Sunset Financial Services was censured and fined by FINRA for two separate matters.

The first action related to Sunset’s selling of private placements as an unaffiliated broker-dealer. In addition to a fine of $200,000, the firm was ordered to disgorge ill-gotten gains of gross dealer concessions and due diligence fees in the amount of $84,253.03, plus interest, as partial restitution to customers.

In one instance, a third-party diligence report on an investment fund sold as a private placement pursuant to Regulation D of the Securities Exchange Act indicated to the firm that there was an increased default rate for the loan portfolio. However, the firm did not follow up adequately, nor did it reevaluate the fund’s appropriateness.

It also failed to follow up on another problem when the fund suspended redemptions and stopped accepting new investors because of financial problems, and also suspended monthly distribution payments to investors. The firm brought in about $1.14 million from sales of these funds, not counting additional trail concessions.

In another instance, a second investment fund was sold only to accredited investors as a Regulation D private placement, when a due diligence report being prepared on that fund had not yet been completed by a third-party due diligence provider. Instead of waiting for the report, the firm sold the fund anyway, and got approximately $45,042.

In addition there were other failures in supervision, as well as in the preparation and review of sales materials. The firm neither admitted nor denied the findings.

In the second, separate action, the firm was censured and fined $20,000 for failure to establish and maintain a supervisory system, including written procedures, regarding the sale of nontraditional ETFs that should have been compliant with applicable NASD and FINRA rules.

The firm allowed its registered representatives to recommend and sell nontraditional ETFs, but its WSPs did not address nontraditional ETFs at all. The firm also failed to conduct due diligence of nontraditional ETF products before allowing representatives to recommend them to customers, did not train its representatives or supervisors on their appropriateness, and did not restrict in any way customers’ ability to trade nontraditional ETFs out of their accounts, or monitor how long open positions in them were held or the amount of losses.

LavaFlow Censured, Fined by FINRA on Execution Failures

New York-based LavaFlow was censured by FINRA and fined $180,000 for failing to execute against delivered orders up to the firm’s displayed, as well as its reserve, size. The firm executed more than 8 million short-sale transactions and failed to report each of the transactions to the FNTRF with a short sale modifier.